Comments on the new cap level and on the post 2030 reduction provisions

Comments on the revised proposed emission trading rule
William M. Shobe, Professor of Public Policy
University of Virginia, February 28, 2019

Recommendations:

1. Return language on post 2030 cap reductions to the language in the original draft rule
2. Retain the new, lower cap levels on 2020 – 2030 emissions
3. Retain the new language on industrial sources

With the post 2030 language returned to the language in the original draft, this proposal represents the most cost effective approach to reducing CO2 emissions in the Commonwealth.

Summary:

The revised version of the proposed rule on emission trading (9 VAC 5-140) contains three substantive changes from the originally propose rule:
1. A change in the way industrial sources are treated,
2. A lower cap, and
3. A provision providing for a default annual reduction in the cap after 2030
I will not discuss the change in the treatment of industrial sources except to say that it is consistent with the structure of RGGI, exempting industrial generators that generate electricity primarily for internal use rather than for sale to the grid. Such exemptions are common in cap and trade programs to prevent leakage of emissions in trade-exposed industries. The changes proposed by the Department of Environmental Quality (DEQ) are appropriate.

The lower cap: In response to public comment on the original proposed rule, DEQ performed additional modeling using more up-to-date assumptions for renewables penetration, electricity demand growth and other factors. Based on this modeling, DEQ recommended a reduction in the initial cap from 33 or 34 million tons per year to 28 million tons per year. This was an appropriate response to the newly available evidence. The new initial cap declining at 3% per year makes Virginia’s level of effort much more consistent with the rest of RGGI.

Post-2030 reductions in the cap: Although DEQ did not recommend that it do so, and against the advice of representatives from the RGGI states, the Air Board voted to include a default reduction of the cap of 840,000 per year for the years 2031-2040. This linear annual reduction is not based on any modeling evidence and renders the Virginia rule inconsistent with the way future emissions are handled by RGGI. This provision should be eliminated and returned to the language of the original proposed rule.

In every other respect, the proposed rule is both consistent with the RGGI approach and appropriate for the specific circumstances of Virginia. Once the unsupported change to the 2031-2040 cap is removed, this proposed rule will be an excellent implementation of the RGGI cap and trade model and will represent a strong yet affordable response to the challenges presented by CO2 emissions from the electricity generation sector.

The lower cap

DEQ made a number of corrections to its original assumptions used in its IPM modeling for the rule. The corrected assumptions included a renewables build-out more consistent with current practice and policy, a more realistic growth rate in electricity demand, and lower natural gas prices. As a result of the more realistic modeling assumptions, the IPM results show a much lower cost of achieving emission reductions. The baseline policy run shows Virginia business-as-usual emissions remaining steady at 29 million tons per year. The baseline 9-state RGGI market is quite slack, with allowance prices at or near the auction reserve price, and the full 10% retirement through the ECR mechanism. In fact, several million tons of allowances remain unsold at the reserve price and are retired.

The model runs with Virginia joining at the lower cap of 28 million tons in 2020 still show some relative slack in the RGGI market. The full 10% of allowances in the ECR are retired, although no allowances are retired due to a failure to meet the auction reserve price. The prices of allowances are somewhat higher in the lower cap scenarios, but still quite modest at under $5 per ton of CO2 (in 2017 dollars). This is about a tenth of the social cost of carbon measure developed to guide current decisions about investment in CO2 emission reductions.

It is important to note that the new, lower cap is not binding on Virginia for cumulative emissions during the 10-year period from 2020 to 2030. The new annual cap levels will not be binding on Virginia emissions until around 2028, at which time, firms will have accumulated a large bank of allowances, which will not be fully depleted by 2030. This does not mean that there is no cost to current emission reductions, only that they are very modest because the cap takes a number of years to fall to levels that are actually binding on emissions. The ability of generators to comply early and accumulate a bank of allowances for later compliance greatly reduces the present value of compliance costs.

The results from the IPM model runs are somewhat hard to interpret, since the IPM modeling does not correctly reflect key provisions of the proposed rule. In particular, the IPM model makes the key assumption that all allowances in RGGI (including Virginia’s) will be sold at auction. It does not accurately reflect the free allocation of allowances to generators and, most importantly, it does not account for the output-based allocation of allowances. My information on this comes directly from Dr. Chris MacCracken, the lead modeler responsible for the IPM model runs at ICF. Dr. MacCracken noted that, while it might have been possible to account for output-based allocation, the normal implementation of the IPM model does not do so, and no such special accommodations were made in the modeling of Virginia joining RGGI. The failure to account for output-based allocation would change both the amount of leakage of generation from Virginia into non-capped states in the PJM RTO and the competitiveness of Virginia generation in the states that are members of both PJM and RGGI. One clear conclusion is that total CO2 emissions are lower with output-based allocation than they would be without it due to reduced leakage and that this improved emission performance is accomplished at very modest cost.

My conclusion is that Virginia joining RGGI at the lower cap of 28 million tons in 2020 is environmentally effective, with little expected leakage into the uncapped portion of PJM. The reductions are achieved for under $4.50/ton of CO2 ($2017), a very modest cost for emission reductions consistent with what Virginia would need to do to bring its electricity sector in compliance with U.S. emission reduction obligations under the Paris Climate Accord.

The cap levels starting with a cap of 28 million tons in 2020 is an appropriate response to the revised modeling exercise carried out by DEQ.

Post-2030 reductions in the cap

It is extremely important that Virginia make every reasonable effort to make its rule consistent with the rest of RGGI. It is only be working together as a block that states can achieve the most cost-effective reductions in emissions. When the Air Board added emission reduction provisions for the period from 2030 to 2040, it violated this principle of comity with the other RGGI states. The history of RGGI makes it abundantly clear that the principle of establishing caps for the next decade based on the best available evidence on compliance costs and then periodically revising those caps downward as justified by newly available evidence has worked extremely well. The two rounds of reductions already in place and the reductions to take effect in 2020 provide ample demonstration of the value of this consensus-based, incremental strategy.

The Air Board’s addition of ad hoc, distant future reductions that are inconsistent with the RGGI model rule, violates the RGGI comity principle and unnecessarily complicates Virginia’s relations with the RGGI states. The Air Board’s actions were not based on any evidence but are, rather, numbers plucked out of the air with no basis in modeling or analysis. The change provides no assurances of additional reductions over what would be achieved through the normal RGGI process of periodic review and revision. This change was made against DEQ’s best advice and in spite of a clear signal from RGGI representatives that the change would violate RGGI comity.

As a result, the changes to the proposed rule that refer to reductions beyond 2030 should be returned to the language in the original proposed rule. Our objective should be to work with RGGI states to achieve the greatest joint reductions possible. It is a disservice to that objective to make ad hoc, purely symbolic statements about distant future reductions, when the RGGI states already have an effective mechanism for revising future caps in response to the evidence as it evolves over time.